Proposed Law on Phoenix Activity Falls Flat

Proposed legislation to attack directors of companies involved in so called “Phoenix” activity appears to have fallen flat owing to two major bungles in the drafting of the amendments in one of the bills.

The Federal Government has released drafts of two Bills. The Bills follow pre-election commitments in the Protecting Workers’ Entitlements package announced in July 2010.

Identifying Phoenix Activity

Distinguishing “Phoenix activity” from the legitimate cycle of business failure is sometimes complicated and involves issues of intention. In the 2009 paper entitled “Phoenix Proposal Paper” (link), the Treasury noted the following:

Defining precisely what constitutes fraudulent phoenix activity is inherently difficult….underlying the distinction between illegitimate, or fraudulent, phoenix activity and a legitimate use of the corporate form, is the intention for which the activity is undertaken. Relevantly, ASIC draws a distinction between businesses that get into a position of doubtful solvency or actual insolvency as a result of poor business practices (for instance, poor record keeping or poor cash management practices) and those operators who deliberately structure their operations in order to engage in phoenix activity to avoid meeting obligations. (emphasis added).

The government’s proposed legislation really does not deal with the difficulty of identifying what is and what isn’t Phoenix activity at all.

the company’s name is the same as or similar to a company or business name of another company that has been wound up; and

the director was also a director of that other company; and

the company incurs the debts within five years after the start of the winding up of the other company.

This bill suffers from two major problems. The first and most obvious problem is that personal liability only applies if the subsequent company has the same or a similar name as the old company. So a director can escape personal liability simply by choosing a new name that is not similar to the old company or business name.

In my view, the director ought be made liable if the new company is carrying on substantially part or all of the same business as the old company, and the Courts should be given some flexibility in applying that test. The name alone is a poor indicator. A list of indicators to be taken into account by the Court could be devised in a similar way as exists in applying other evaluative tests, such as section 425(8). They might include the assets employed, the customer base, the nature of the business conducted, the name of the business, the premises used and the staff employed among other things. A defence should be available if the director can show that the old company was given fair value for the business. Further, the Court should have a discretion to excuse directors who have acted honestly and who in the circumstances ought be excused (as exists in the draft bill) to deal with the issue of intention identified in the 2009 paper I noted above.

The second problem is that the director is liable for the debts of the new company, not the old. The drafters appear to have copied similar legislation in the UK and in New Zealand. The idea is to hinder phoenix operators from transferring the name of the business and therefore its goodwill, by restricting the limited liability of the new company.

But in most phoenix cases, the creditors of the new company are not at risk since they are usually trade creditors whom the directors need to keep happy. It is the old company’s creditors like the ATO and other non essential suppliers who need help.

There are a plethora of articles available on the exposure drafts, including very useful posts by AAR (link), Minters (link) and Carrie Rome-Sievers of the Victorian Bar (link) which goes into some detail about the politics of the bills.

The two problems I have identified have both been drawn to the Federal government’s attention in submissions by various bodies and we can only hope that Canberra will fix them.

Providing Access to the GEERS Scheme

The second bill is the Corporations Amendment (Phoenixing and Other Measures) Bill 2012. It provides ASIC with administrative power to order that a company be wound up, generally in circumstances where ASIC considers that the company has been ‘abandoned’. This will trigger employees’ entitlements under the Government’s General Employee Entitlements and Redundancy Scheme (GEERS).

The second bill is a welcome development as in the past, employees or other creditors left abandoned in the old company shell had to go to the expense of winding up the shell at their own expense.